Analysis of Sainsbury's Financial Strategy

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An analysis of Sainsburys financial strategy.

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Analysis of Sainsbury's Financial Strategy

  1. 1. Financial Strategy Analysis of Sainsbury plc.’s Financial StrategyWritten byJason Cates 0
  2. 2. © Jason Cates, 2012Reproduction for the following uses is authorised provided the source is acknowledged in-line with the Copyright, Designs and Patents Act 1988;Private and research study purposes, performance, copies or lending for educationalpurposes, criticism and news reporting, incidental inclusion and copies and lending bylibrarians. Further details of authorised use under the above Act is available from the UKCopyright Service.This publication may be made available online at SlideShare.net/AdrJasonCates for publicuse no earlier than 09:00hrs (GMT) on 21 January 2013 as deemed appropriate by theacknowledged source.This paper has referenced appropriate sources in-line with Harvard Referencing.Any queries regarding this publication should be sent to:AdrJasonCates@GoogleMail.com orLinkedIn.com/in/AdrJasonCatesTo be delivered to the University of Hertfordshire on or by18 December 2012Ordered by Jason Cates to be printed14 December 2012Printed in the United Kingdom 1
  3. 3. Evaluate Sainsbury’s choice of sources of funds using appropriate theoryEvaluate Sainsbury’s dividend policy by using appropriate theoryRecommend an appropriate financial strategy for Sainsbury to be followed over the next 3years.Follow a report format.Use Sainsbury’s financial data for the last 3-5 years in order to evaluate Sainsbury’s financialstrategy.Use corporate life cycle theory to evaluate Sainsbury’s financial strategy.Use other relevant corporate finance theory (e.g. M&M, Lintner, etc) to evaluate Sainsbury’sfinancial strategy.Take into consideration the current economic climate when recommending an appropriate financialstrategy for Sainsbury. Also, your recommendations should be based on the findings of your analysisof Sainsbury’s financial strategy.Use appropriate referencingUse appropriate sources (for example, Sainsbury annual report, Refereed journals, Books). Do NOTuse sources such as Wikipedia, investopedia, etc. 2
  4. 4. Table of ContentsIntroduction ............................................................................................................................................ 4 Aim ...................................................................................................................................................... 4 Setting the Scene ............................................................................................................................ 4Part I ........................................................................................................................................................ 5 Sources of Finance .............................................................................................................................. 5 Long-Term vs. Short-Term Debt (Positive)...................................................................................... 5 Trade Payables (Stable) ................................................................................................................... 6 Debt vs. Equity (Stable) ................................................................................................................... 7 Implications ......................................................................................................................................... 8 Gearing (Stable) .............................................................................................................................. 8 ROCE (Stable) .................................................................................................................................. 8 Cash and Cash Equivalents (Negative) ............................................................................................ 9 Boston Matrix (Positive)................................................................................................................ 10Part II ..................................................................................................................................................... 11 Dividend Policy .................................................................................................................................. 11 Cost of Capital (Stable).................................................................................................................. 11 Shareholder Return ....................................................................................................................... 12 Recommendations ............................................................................................................................ 15 Debt Finance ................................................................................................................................. 15 Equity Finance ............................................................................................................................... 15 Cash Reserves ............................................................................................................................... 15Part III .................................................................................................................................................... 16 Signatories......................................................................................................................................... 16 References ........................................................................................................................................ 17 3
  5. 5. IntroductionAimThis report is carried out with the aim of analysing and evaluating Sainsbury’s financial strategy andmakes appropriate recommendations regarding its future strategy over the next 3-5 years. This willbe carried out by evaluating Sainsbury’s current sources of finance and analysing their financialimplications. This will be carried out in the context of Sainsbury’s past financial strategy as well as itslong-term dividend policy.Setting the Scene In March 2012, Sainsbury’s total liabilities increased by £736m (12.32%). This is while equity,including retained earnings and reserves, increased by £205m (3.78%). This included an 11.89%increase (£278m) in long-term borrowings and a 5.51% (£143m) increase in trade payables. Thisincrease in trade payables was in-line with Sainsbury’s growth in revenue which stood at 5.65%(£1.192bn). In total, long-term debt in 2012 made up 53.27% of Sainsbury’s total liabilities, up from50.76% in 2011. (Sainsbury, 2012) As stated above, Sainsbury’s use of debt grew faster than its use of equity. This increasedgearing from 33.4% in 2011 to 35.2% in 2012. This increase in debt for 2012 was fuelled by Sainsburyincreasing “investment in property, plant and equipment” and other revenue generating assets. Thisis while Sainsbury’s net debt fell by 11.2% (£168m). This shows that increasing levels of Sainsbury’sdebt has been used to fund investment in cash and “other interest bearing assets”. In this context,net debt made up 21.1% of capital employed, down from 23.6% the previous year. (Sainsbury, 2012) 4
  6. 6. Part ISources of FinanceLong-Term vs. Short-Term Debt (Positive) Long-term debt has played an increasing part of Sainsbury’s financial strategy. In 2008, long-term debt made up 48.4% of Sainsbury’s total debt. However, by 2012 this proportion had increaseto 53.27%. This increase in long-term borrowings has helped fund investment in PPE and otherrevenue generating assets. (Sainsbury, 2012) Long-Term vs. Short Term Debt 60.00% 53.27% 55.00% 51.20% 51.60% 52.57% 50.76% 50.00% 45.00% 48.80% 48.40% 47.43% 49.24% 46.73% 40.00% 2008 2009 2010 2011 2012 Non-Current Liabilities Current Liabilities (Sainsbury, 2012) This long-term financial strategy will provide Sainsbury with more time and flexibility torepay this debt, thus reducing its financial risk. This long-term financial policy will promote long-termstability and help minimise the long-term costs of capital. This increasing use of long-term debt has helped facilitate Sainsbury’s growth in both in-store and online sales. (IR, 2012) This growth in “multi-channel” sales helps to diversify Sainsbury’srevenue streams and helps to ensure long-term sustainability by reducing overall business risk. Thisincludes investing in growing markets such as China whilst locking in lower interest rates over thelong-term. (Sainsbury, 2012) 5
  7. 7. Trade Payables (Stable) Growth in Revenue and Trade Trade Payables as a Proportion of Payables Revenue 10.00% 13.50% 5.00% 13.00% 12.50% 0.00% 2009 2010 2011 2012 12.00% -5.00% 11.50% Revenue Trade Payables 2008 2009 2010 2011 2012 (Sainsbury, 2012) Over the last two years, growth in trade payables has remained in-line with revenue.However, in 2010, Sainsbury repaid some of its trade payables after growth exceeded that ofrevenue in 2009. Since then, trade payables have remained at roughly 12.3% of revenue. This islower than Sainsbury’s closest competitor Tesco with trade payables of 19% of revenue, but higherthan that of Morrison’s with 11.5%. (FT, 2012c) In 2012, Sainsbury’s trade payables equated to 47.4 payable days, declining from 50.8 daysin 2009. (Sainsbury, 2012)This reduction will provide Sainsbury with greater financial flexibility asmarket growth staggers and trading conditions remain tough. This policy, if maintained, with helppromote long-term flexibility and growth. However, Sainsbury must ensure it can maintain this debtover the long-term as not to increase its financial risk. 6
  8. 8. Debt vs. Equity (Stable) This report will now analyse Sainsbury’s use of debt in proportion to equity as a source offinance. This report will also consider Sainsbury’s net debt which includes deductions such as cashand other interest bearing assets. Debt vs. Equity Net Debt vs. Equity 1.5 0.4 0.3 1 0.2 0.5 0.1 0 0 2008 2009 2010 2011 2012 2008 2009 2010 2011 2012 (Sainsbury, 2012) Sainsbury’s debt has remained relatively stable over the last five years increasingproportionately with equity. As such, gross debt has remained at roughly 1.16 times equity.Furthermore, Sainsbury’s net debt, which deducts cash and other “interest bearing financial assets”,has also remained stable at roughly 0.29 times equity. As par the annual report, Sainsbury’s increasein gross debt during the financial year 2012 was due to increasing “investment in estatedevelopment”. (Sainsbury, 2012) 7
  9. 9. ImplicationsGearing (Stable) Gearing 50.0% 40.0% 30.0% 20.0% 10.0% 0.0% 2008 2009 2010 2011 2012 (Sainsbury, 2012) In 2012, Sainsbury’s gearing stood at 35.2%, up from 33.4% a year before. However, overallthis gearing has remained relatively stable over the last 5 years ranging from 30% in 2008 to 38%2009 and then falling back again in 2010. Therefore, this paper considers Sainsbury’s gearing to bestable with no corrective action being required at the present time. More recent increases in gearingcan be associated with the financing of new revenue generating assets such as new stores and otherrelevant PPE. As such, once these assets reach their full operational capacity, gearing will naturallyfull back towards 30% as time progresses. (Sainsbury, 2012)ROCE (Stable) Pre-Tax Return on Capital Employed 12.00% 10.00% 8.00% 6.00% 4.00% 2.00% 0.00% 2008 2009 2010 2011 2012 (Sainsbury, 2012) Between 2008 and 2010, Sainsbury’s return on capital employed increased steadily untillevelling out at 11% in 2010 and rising to 11.1% the following year. This stability is attractive to long- 8
  10. 10. term investors who look to base their returns on high dividend yields rather than through increasingcapital value. In addition, ROCE has remained stable whilst liabilities and equity have increased. Thisshows that this additional finance has been appropriately invested in revenue generating assets asto maintain this stable return. (Sainsbury, 2012)Cash and Cash Equivalents (Negative) Cash and Cash Equivalents Cash and Cash Equivalents 1000 15.00% 800 10.00% 600 5.00% 400 0.00% 200 2008 2009 2010 2011 2012 0 2008 2009 2010 2011 2012 Cash/Assets Cash/Liabilities (Sainsbury, 2012) Sainsbury’s cash level has remained relatively stable over the last 5 years ranging from£837m in 2010 to £501m in 2011. Cash more recently stood at £739m in the financial year 2012.(Sainsbury, 2012) Furthermore, between 2008 and 2010, cash remained at an average rate of 13% ofliabilities. (Sainsbury, 2010) However, in 2011, this proportion fell to 8.4%; such falls would beunsustainable in the long-term and could potentially increase Sainsbury’s business risk. (Sainsbury,2011) This is due to cash acting as a safety barrier if and when trading activity declines. Therefore,Sainsbury must ensure it retains adequate cash reserves to mitigate this business risk associatedwith corporate growth, especially when expanding into the area of banking. Furthermore, cash isrequired to fund investment in new ventures and helps provide companies with new long-termgrowth opportunities. (Watson & Head, 2010) 9
  11. 11. Boston Matrix (Positive) (Sainsbury, 2012) As shown in the matrix above, growth in Sainsbury’s in-store sales are likely to remainstagnant for the foreseeable future. Thus, Sainsbury is now required to look elsewhere in regards tofuture growth prospects. Therefore, this in-store retail is now used as a “cash cow” to fund newventures such as online retail which could be considered a “Star”. (IR, 2012) More recently,Sainsbury expanded into banking which could be considered a “Question Mark”, but verging onbecoming a “star”. (Sainsbury, 2012) This broad mix of cash generating business alongside new highgrowth ventures will help to ensure Sainsbury’s long-term sustainability and growth. This increaseddiversity will also help reduce Sainsbury’s overall business risk. (Watson & Head, 2010) 10
  12. 12. Part IIDividend PolicyCost of Capital (Stable) Cost of Capital 20.00% 15.00% 10.00% 5.00% 0.00% 2008 2009 2010 2011 2012 Cost of Debt Cost of Equity WACC (Sainsbury, 2012) In recent years, Sainsbury’s long-term cost of equity has increased in-line with gearing. Inaddition, Sainsbury’s cost of debt increased to 5.2% in 2012, up from 4.64% a year before. Overall,Sainsbury’s cost of capital stood at 10.8%, up from 10.4% in 2011, but has remained relatively flatsince 2009. This stability is due to the increasing costs of maintaining equity being offset by thelower cost of debt. (Sainsbury, 2012) These costs are likely to remain stable for the foreseeable future as long as gearing remainsstable. However, if gearing does start to increase, this will increase the company’s financial andbankruptcy risk and thus increase its cost of equity. However, if this debt is largely made up of long-term debt, this will lock in the current interest rate for a greater length of time. This will allowSainsbury more time to take corrective action as required. (Watson & Head, 2010) In-line with Miller and Modigliani’s first theorem, changes in Sainsbury’s cost of equity hasremained in-line with gearing. However, decreases in gearing have resulted in the cost of equityremaining flat rather than fall. Additionally, Sainsbury’s cost of debt has also fluctuated, lagging ayear behind gearing. This suggests that gearing also has an effect on a company’s cost of debt. 11
  13. 13. However, in 2012, Sainsbury’s use of debt did produce a tax shield worth £23.04, thus helping tomitigate any rise in overall costs of capital. (HMRC, 2012)(Sainsbury, 2012) Interest Cover 10.00 8.00 6.00 4.00 2.00 0.00 2008 2009 2010 2011 2012 (Sainsbury, 2012) Sainsbury’s interest cover increased significantly in 2010 reaching 8.7 times, up from 5.6times a year before. However, since then it has gradually declined having fallen to 7.5 times by 2012.(Sainsbury, 2012)This suggests that Sainsbury’s current business model gradually reduces thecompany’s effective interest cover with corrective action thus being required every few years. Thismay be of concern during the years in which corrective action is required due to potentialinvestments being forsaken to carry out such corrective action.Shareholder Return Cost of Capital (Dividend Yield) Dividend Yield 8.00% 6.00% 6.00% 4.00% 4.00% 2.00% 0.00% 2.00% 2008 2009 2010 2011 2012 0.00% Cost of Debt Dividend Yield WACC 2008 2009 2010 2011 2012 (Sainsbury, 2012) (HL 2012) As shown in the graphs above, Sainsbury’s dividend yield (Short-term cost of equity)remained at 4.3% between the years 2009 to 2011 and then rose to 5.3% in 2012. (JL, 2012) This is 12
  14. 14. higher than its main competitive rivals Tesco (4.38%) and Morrison (4.1%). In addition, since March2009, Sainsbury’s share price has fallen by 1.17%, significantly less than Tesco at 13.84% andMorrison with 3.52%. (FT, 2012a) (FT, 2012b) This description of Sainsbury is similar to that of amature company with shareholder returns being in the form of dividends with the value of capitalinvested remaining stable. Relating this to Sainsbury’s cost of equity, the dividend yield reflects the changes inSainsbury’s share price as well the rate of dividend. Simply, the dividend yield illustrates the cost ofissuing new equity whilst the overall cost of equity illustrates the cost of maintaining equity. (FT, 2012c) This type of dividend policy appeals more to long-term investors such as pension funds. Thisis due to their desire for high dividend paying investments with little need to cash out. Therefore,minor changes in share prices may not be an overwhelming factor in their decision-making process.However, short-term investors will be turned off by such a policy due to their desire for highercapital growth over dividend pay-outs. Therefore, Sainsbury must consider which type ofshareholder it wishes to attract which will raise them the most finance at the lowest cost, as well asthe signalling effects this may have. (Watson & Head, 2010) Relating this to Lintner’s theorem, changes in Sainsbury’s rate of dividend directly reflects itsearnings per share in the sense that it has have remained broadly flat. In addition, any increase in 13
  15. 15. dividend is only implemented once increased earnings are secure and are proven to be sustainable.This is to ensure such changes in dividend do not then have to be reversed at a later date which maygive the wrong impression in relation to the signalling effect. Thus, Sainsbury’s dividend policy is in-line with Lintner’s theorem and is appropriate for its stage in the corporate life cycle. (Johnson,Scholes, & Whittington, 2008) Dividend Cover 2.00 1.50 1.00 0.50 0.00 2008 2009 2010 2011 2012 (Sainsbury, 2012) In relation to Sainsbury’s ability to maintain this dividend, we must consider the dividendcover. As shown in the graph above, between 2008 and 2011, Sainsbury’s Earnings per shareincreased to a greater extent than its dividend payments, thus increasing its overall dividend cover.However, the dividend cover remained flat in 2012 due to Sainsbury’s higher rate of dividend. Thisgeneral trend shows that Sainsbury will be in a position to maintain this dividend for the foreseeablefuture with no corrective action being required. (Sainsbury, 2012) 14
  16. 16. Recommendations Overall, Sainsbury’s financial outlook remains stable. However, we do recommend minoralterations to take place over the next 3 years which will help promote long-term sustainability andhelp mitigate Sainsbury’s long-term financial risk. These recommendations are based on theassumption of economic actively remaining flat for the foreseeable future. Any improvement ordecline in such activity will therefore require a change in short to medium term financial strategy.Debt Finance Due to the recent falls in Sainsbury’s cost of debt, we recommend locking in this rate byreplacing short-term debt with longer term debt. This will reduce the volatility in Sainsbury’s cost ofdebt and help encourage long-term sustainability. This will reduce Sainsbury’s financial risk andallow more time to take corrective action if and when these costs start to increase.Equity Finance In addition, any increase in the use of equity as a source of finance should be issued in sucha way that doesn’t significantly impede the company’s long-term dividend cover. This means anyincrease in in the use of equity should be lower than or equal to Sainsbury’s growth in net profits.This will help ensure Sainsbury’s rate of dividend and overall costs of equity remain sustainable inthe long-term. Simply, Sainsbury’s current dividend policy should remain in place with any changebeing proportionate to long-term sustainable profits.Cash Reserves In order to mitigate long-term business risk, Sainsbury should retain cash at a levelproportionate to its liabilities. This is especially the case if Sainsbury is to consider expanding into theretail banking industry. Therefore, this paper recommends Sainsbury maintain cash levels equal to orgreater than 10% of Sainsbury’s total liabilities. This cash will act as a safety barrier against anyincreases in overall business risk. 15
  17. 17. Part IIISignatoriesI commend this paper to the University of Hertfordshire to be delivered on or by 18 December 2012.Jason Cates ___________ Mail: AdrJasonCates@GoogleMail.com Portfolio: SlideShare.net/AdrJasonCates LinkedIn: LinkedIn.com/in/AdrJasonCates 16
  18. 18. ReferencesFinancial Times (2012a) Tesco PLC. Available at:http://markets.ft.com/Research/Markets/Tearsheets/Summary?s=TSCO:LSE [Accessed: 7thDecember, 2012]Financial Times (2012b) WM Morrison Supermarkets PLC. Available at:http://markets.ft.com/research/markets/Tearsheets/Summary?s=MRW:LSE [Accessed: 7thDecember, 2012]Financial Times (2012c) J Sainsbury PLC. Available at:http://markets.ft.com/research/Markets/Tearsheets/Summary?s=SBRY:LSE [Accessed: 7thDecember, 2012]Hargreaves Lansdown (2012) Sainsbury (J) plc Company Overview and Comment. Available at:http://www.hl.co.uk/shares/shares-search-results/s/sainsbury-j-plc-ordinary-28,47p/research&ei=I7u_UIj1LtC10QWClID4DA&usg=AFQjCNFU4grqJmWscd7RFqf8h_b8jQmwQA[Accessed: 14th December 2012]HMRC (2012) Corporation Tax Rates. Available at: http://www.hmrc.gov.uk/rates/corp.htm[Accessed: 7th December 2012]Internet Retailing (2012) Sainsbury’s claims number two spot in online grocery market. Available at:http://internetretailing.net/2012/03/sainsburys-claims-number-two-spot-in-online-grocery-market/[Accessed: 7th December 2012]Johnson, G., Scholes, K. & Whittington, R. (2008) Exploring Corporate Strategy. 8th edn.Harlow:PearsonSainsbury (2009) Annual report 2009. [Online] Available at: http://www.j-sainsbury.co.uk/media/171784/ar2009_report.pdf [Accessed: 23rd November 2012]Sainsbury (2010) Annual report 2010. [Online] Available at: http://www.j-sainsbury.co.uk/media/171797/ar2010_report.pd [Accessed: 23rd November 2012]Sainsbury (2011) Annual report 2011. [Online] Available at: http://www.j-sainsbury.co.uk/media/171813/ar2011_report.pdf [Accessed: 23rd November 2012]Sainsbury (2012) Annual report 2012. [Online] Available at: http://www.j-sainsbury.co.uk/media/649393/j_sainsbury_ara_2012.pdf [Accessed: 23rd November 2012]Watson, D. & Head, A. (2010) Corporate Finance: Principles and Practice. 5th edn. Harlow:Pearson 17
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